Greater respect for consistently profitable companies

When I was young and stupid, I had unrealistic expectations of my investments. I thought I would find very small companies that would barely be profitable at the time I'd buy them, but then would make huge profits after I bought them.

After turning over many rocks and looking at hundreds of companies, I have discovered that many financially-upside-down companies remain in that state for a long time. And that many companies that have demonstrated success in the past continue to do so in the future. In other words, many companies do not revert to the mean. I think this is one part of why owning the index works so well -- the index contains companies that have demonstrated success in the past.

There is a bias in many value investors against popular names (or names in the index). Take AAPL for example. Many "value" investors would avoid it simply because they think it's too popular. Instead, they would rather buy some unknown micro cap that is barely profitable or a turnaround story. But if you look at AAPL objectively, you will see that from a pure numbers point of view, it is an outstanding company. Not many companies in the world can boast a 22% net margin and a 26% CAGR growth in EPS for 10 years.

The more I look at average companies that are present in the index, the more respect I have for such outstanding companies. Companies like V, MA, ROST and ODFL are rare gems in a sea of mediocrity. If you try to wait to buy these companies, you need a lot of patience, because crown jewels are rarely on sale. My strategy now is to buy a small piece of the company as soon as I recognize the quality of the business. And then I wait for the price to become cheap to increase my position to a full position. Such a strategy should work out over time, and I'll post an update in a few years after examining the results.

Ulta Beauty: Beautiful Figures

Retailing is generally a tough business. There is a lot of price competition that keeps margins low. There is also inventory risk. Still, even in tough environments, some retailers manage to stand out and earn good returns on capital. ULTA is one of them.

ULTA is a specialty retailer that sells beauty-related products to shoppers. This includes cosmetics, haircare, skincare, etc. products. They are the largest beauty-related retailer in the US and have experienced stellar growth in the past:

10-year growth CAGR figures:

Revenue: 19%
Operating Income: 34%
EPS: 37%

Interestingly enough, shares outstanding only went from 59M to 62M during this time and total debt went down from 106M to 0! So all of this growth was financed mostly from within the business.

While past growth has rewarded past shareholders, we care about the future. I think there is plenty of growth still to be had for ULTA:

1. Number of physical stores can double from 1k to 2k.
2. Ecommerce sales can grow at double-digit CAGR for the next 10 years.
3. There should be operating leverage at play.

In 5 years (by 2023), I expect revenue to be $8B, up from the current $5.8B. Net Income should be 12% of that, which means $880M. Share count may be around 58M which means EPS will be $15. A multiple of 18x seems reasonable to me, which means the stock will trade at $270.

At a current price of $250 or so, the stock doesn't offer very attractive returns, but it should be a buy around $150 or so. I wish I had read the annual reports of ULTA a few years earlier!